1. Why is a new banking recovery and resolution framework needed for the EU?

The financial crisis provided clear evidence of the need for more comprehensive and effective arrangements to deal with failing banks at national level, as well as the need to put in place arrangements better able to cater for cross-border banking failures.

There has been a number of high profile banking failures during the crisis (Fortis, Lehman Brothers, Icelandic banks, Anglo Irish Bank) which have revealed serious shortcomings in the existing arrangements.

In the absence of mechanisms to organise an orderly wind down, EU Member States have had no choice other than to bail out their banking sector. State aid to support banks has amounted to 13% of GDP. The impact on taxpayers is obvious.

A new crisis management framework is essential to complement other work streams aimed at making the financial system sounder, i.e. making banks stronger with higher levels of and better quality capital, greater protection of depositors, and better supervision.

2. What are the main elements of the Consultation?

The Consultation seeks stakeholders' views on a comprehensive set of measures aimed at ensuring that national authorities are equipped with the necessary tools to intervene in a troubled institution at a sufficiently early stage to address developing problems; that firms and authorities make adequate preparation for crises; that national authorities have common resolution tools and powers to take rapid and effective action when bank failure cannot be avoided; and that authorities cooperate effectively when dealing with the failure of a cross-border bank. These measures include:

Preparatory and preventative measures, such as a requirement for institutions and authorities to prepare recovery and resolution plans to ensure adequate planning for financial stress or failure (see also question 4), and powers for authorities, where they identify obstacles to resolvability in the course of this planning process, to require a bank to take appropriate measures to ensure that it can be resolved with the available tools in a way that does not threaten financial stability and does not involve costs to the taxpayer (see also question 5);

Powers to take early action to remedy problems at a sufficiently early stage,such as powers for supervisors to require the replacement of management, to require an institution to implement a recovery plan or to divest itself of activities or business lines that pose an excessive risk to its financial soundness, or to appoint a special manager (see also question 7);

Resolution tools, such as powers to effect the takeover of a failing bank or firm by sound institution, or to transfer all or part of its business to a temporary bridge bank, which enable authorities to ensure the continuity of essential services and to manage the failure in an orderly way (see also question 8). In this context, the Consultation also seeks views on mechanisms to write down or convert to equity appropriate classes of debt of failing institution ('bail in') in order to strengthen its financial position and allow it to continue as a going concern subject to appropriate restructuring (see also questions 9 and 10).

A framework for cooperation between national authorities so that where a cross-border banking group fails, national authorities will coordinate resolution measures to protect financial stability in all affected Member States and achieve the most effective outcome for the group as a whole.

The overriding aim is to put in place a framework that will allow a bank to fail – whatever its size, complexity or importance for the financial system - while ensuring the continuity of essential banking services, minimising the impact of that failure on the financial system and avoiding costs to taxpayers. This is essential to avoid the 'moral hazard' that arises from the perception that some banks are too big, complex or interconnected to fail.

3. Why didn't the EU have this framework in place before the crisis? And what has been done since the crisis?

Until the crisis, many felt that crisis management was best dealt with at national level especially if there was a risk that there would be budgetary implications and in view of the close connection of crisis measures with national insolvency regimes. Measures in place varied greatly between Member States.

However, the crisis has strengthened the case for action at EU level, since it clearly demonstrated that the absence of European arrangements could result in ad hoc national solutions, which might be less effective in resolving the situation and ultimately prove more costly for national taxpayers. Furthermore, the crisis highlighted there were no mechanisms in place to deal with failing banks that operate in more than one Member State.

4. What sort of preparatory and preventative measures does the Commission consider necessary?

Preventative measures will include measures designed to ensure that developing problems will be identified and addressed at an early stage, and to enhance the preparedness of firms and authorities to deal effectively with serious difficulties. These will include reinforcing supervisory powers (e.g. enhanced supervision with more intrusive assessments, more systematic on-site examinations, etc.) and introducing a requirement for firm-specific recovery and resolution plans. The recovery part would be prepared by firms, and set out measures that the firm would take to deal with funding problems in a range of conceivable stressed scenarios.

The resolution part would be prepared by authorities with the cooperation of firms, and would put in place plans as to how the firm might be resolved, and its essential functions preserved, in the event of the firm's failure.

Preparatory and preventative measures might also include powers for authorities to take measures, or require a firm to make changes to its structure or business organisation, if the authorities assess that the firm is not resolvable with the available tools (see also question 5).

5. What kinds of changes to legal or operational structures would authorities be able to require?

The Consultation seeks stakeholders' views on powers which would be available where, in the course of resolution planning, authorities identify obstacles to resolvability in individual institutions. The powers being considered would allow authorities, following an extensive dialogue with the bank involved, to require it to take appropriate measures to ensure that it can be resolved with the available tools in a way that does not threaten financial stability and does not involve costs to the taxpayer. Such measures might include requiring the bank to draw up service level agreements to cover the provision of critical economic functions, to limit exposures, to cease or limit specific activities or the development of new products or business lines, or to make structural changes to the way the bank organises its business – for example by better mapping systemic functions to legal entities. Because such powers may be intrusive, the Consultation discusses appropriate safeguards, including the requirement that any measure required must be necessary, proportionate and suitable for achieving the exclusive objective of removing the specific impediments to resolution arising from the organisation of the bank's business or its legal structure that have been identified. The Consultation also discusses procedural safeguards for banks, including a right to judicial review.

6. What new early intervention measures are being considered?

The Consultation seeks views on possible new early intervention powers for banking supervisors designed to address developing problems within individual banks and across banking groups at an early stage, to prevent them from developing further and secure recovery. Measure under consideration include powers for supervisors to prohibit payment of dividends, to require the replacement of managers or directors, to require the bank to divest itself of certain activities or business lines, the power to require implementation of a firm's recovery plan to address specific funding problems, and the power to appoint a special manager for a limited period to take over control and run the bank with the objective of addressing its problems and restoring it to financial health.

7. What is the function of a special manager?

The Consultation seeks the views of stakeholders on the appointment of a special manager as one early intervention tool that might be made available to supervisors. A special manager could be appointed to replace or assist the management of a troubled institution for a limited and specified period. His or her primary function would be to restore the financial situation of the bank by implementing an appropriate recovery plan. The special manager would have all the powers of the managers of the company, and would not have any powers to override the rights of shareholders under the company statutes and company law. In particular, shareholder approval would be required for any actions taken by the special manager if the same action would require such approval if taken by the ordinary directors.

8. What are resolution measures?

Resolution occurs at a point when the institution has reached a point of distress such that there are no realistic prospects of recovery over an appropriate timeframe and all other measures have been exhausted. The resolution tools considered in the Consultation include a sale of business tool (parts of the credit institution or parts of its business can be sold to one or more purchasers without the consent of shareholders); a bridge bank tool (authorities can transfer some or all of the business to a temporary bridge bank in order to preserve essential banking functions or facilitate continuous access to deposits); and an asset separation tool (to remove toxic assets to a separate vehicle). In addition, the Consultation seeks stakeholders' views on possible mechanisms to write down the debt of a failing bank, or to convert it to equity, as a means of restoring the institution's capital position ('bail in'). This would allow the bank to be restructured as a going concern or wound down in an orderly manner, and may provide an additional resolution tool that would give authorities further flexibility to deal with the failure of complex institutions.

9. What is the proposal to write down creditors ('bail in') and how would it work?

The objective is to develop a mechanism for recapitalising failing institutions so that it can continue to provide essential services, without the need for bail out by public funds. Fast recapitalisation would allow the institution to continue as a going concern, avoiding the disruption to the financial system that would be caused by stopping or interrupting its critical services, and giving the authorities time to reorganise it or wind down parts of its business in an orderly manner. In the process, shareholders should be wiped out or severely diluted, and culpable management should be replaced. The consultation seeks views on two broad approaches to achieving this objective.

The first approach would involve a broad statutory power for authorities to write down or convert unsecured debt, including senior debt (subject to the possible exclusions for certain classes of senior debt that may be necessary to preserve the proper functioning of credit markets). It is not envisaged that such a power would apply to existing debt that is currently in issue, as that could be disruptive.

The second approach would require banks to issue a fixed amount of 'bail-in' debt that could be written off or converted into equity on a specified trigger linked to the failure of the bank. This requirement would be phased in over an appropriate period and, again, it is not envisaged that any existing debt already in issue would be subject to write down.

10. How does the 'bail in' tool relate to discussions regarding sovereign debt?

It does not. Banks, as private companies, and Countries, are fundamentally different and the principles underpinning this consultation and the possible design features of the bail in tool, should not be read across to the current debate around sovereign debt. Any legislative proposal for a debt-write down mechanism that might be made in the wake of this Consultation would only apply in relation to relevant classes of debt issued by banks (and the Consultation seeks stakeholders' views on what classes of bank debt should be covered). It would not apply to debt issued by governments.

11. How is cross-border cooperation addressed in the Consultation?

Beyond ensuring common tools in all Member States, it is also necessary to ensure smooth cooperation both in advance of and during a crisis. The Consultation seeks views on a cross-border coordination framework based on "resolution colleges" for each cross-border bank that would include all relevant national supervisory and resolution authorities, and would build on the existing supervisory colleges (which are being established for cross-border banks under the Capital Requirements Directive (CRD 2, see IP/08/1433). These colleges would be responsible for planning (preparation of resolution plans, agreeing principles for burden sharing, etc.) and would be a forum for information exchange and coordination during a crisis. The Consultation also seeks views on a role in appropriate cases for group resolution authorities to draw up a group resolution scheme, which would then be implemented by national authorities. Finally, the Consultation seeks views on the appropriate role for the newly established European Supervisory Authorities (see MEMO/10/434) in the preparatory, preventative, early intervention and coordination parts of the new framework.

12. How will resolution schemes be financed?

Financingis a key part of resolution, and the Commission believes that a coordinated approach is needed in order to improve the prospects for effective cross-border cooperation. In May 2010, the Commission set out its ideas for pre-funded bank resolution funds (see IP/10/610 + MEMO/10/214) to ensure that the banking sector, and not the taxpayer, pays the costs of future bank failures. The Commission's Communication of 20 October 2010 (see IP/10/1353 + MEMO/10/506) elaborates on those ideas. This Consultation suggests how those ideas might be implemented, further explores how resolution funding might be articulated with existing deposit guarantee schemes and seeks views on possible bases for contributions from financial institutions to resolution funding.

13. Is this work intended to solve the current crisis?

The financial and economic crisis has called for extraordinary measures to be taken in order to avert a potential meltdown of the global financial sector. However the measures included in this Consultation are aimed at dealing with future bank failures. Early supervisory intervention should assist in averting preventable bank failures, while an EU resolution framework would equip national authorities with adequate tools to manage the consequences of failures that could not otherwise be avoided.

14. Resolution measures may interfere with the rights of shareholders and creditors. How is this addressed in the Consultation?

Bank resolution tools that involve transfer of assets may interfere with the rights of creditors and shareholders, and any EU resolution framework would need to incorporate adequate safeguards to protect those interests.

For example, EU company law contains a number of mandatory requirements that confer rights on shareholders. These include pre-emption rights, and the requirements that any increase or reduction of issued share capital is approved by the shareholders' general meeting. In addition to this, any transfer of ownership or assets of an ailing bank must comply with shareholders' right to property under the European Convention on Human Rights. A balance needs to be struck between protecting the legitimate interests of shareholders and enabling resolution authorities to intervene quickly and decisively to restructure a failing institution or group to minimise contagion and ensure the stability of the banking system in affected Member States.

The Consultation seeks views on appropriate mechanisms for redress and compensation for shareholders and creditors whose rights are affected, and on the general proposition that they should as far as possible, be no better and no worse off than they would have been had the bank under resolution been wound up under the applicable insolvency law.

The Consultation also seeks views on the possible limitation of the remedies available in judicial review to persons affected by resolution actions to financial damages, preventing courts from reversing or invalidating transfers that have already been made.

15. What kinds of financial institution would be covered by an EU regime?

The Consultation focuses on intervention and resolution measures for banks because their unique role as providers of credit, deposit-takers and payment intermediaries gives rise to particular problems and public policy objectives in the event of a bank failure. In addition, it seeks views on the inclusion of investment firms whose failure might also risk financial stability.

Beyond that, the Commission also recognises that different kinds of crisis management measures may be necessary to address the specific risks to market stability represented by other types of financial institution. It intends to carry out further work by the end of 2011 to consider which crisis management arrangements might be necessary for other types of financial institution, including insurance companies, investment firms and Central Counterparties.

16. Would "living wills" be required for all banks and who would prepare them?

There are currently no harmonised powers for supervisors to require banks to prepare recovery and resolution plans, often referred to as "living wills". These would be composed of 'recovery plans' drawn up by banks detailing how they would respond to a range of conceivable circumstances of financial stress, and 'resolution plans' prepared by authorities with a view to ensuring that authorities can act quickly and effectively in the event of a crisis. The Consultation seeks views on a general requirement for recovery and resolution plans to be maintained for all banks. However, the requirement would apply proportionately. This might mean, for example, that for smaller institutions with no cross-border operations, the resolution plan might simply specify that the institution would be wound up, accompanied by payout to depositors by the Deposit Guarantee Scheme. For systemically important cross-border financial institutions the "living wills" would be expected to be considerably more detailed, so as to facilitate, in a period of severe financial stress or instability, the continuity of its financial infrastructure services and the rapid resolution or winding down where necessary of the institution (or part of the institution).

17. What is the role of the EBA in resolution and are you proposing a European banking resolution authority ?

As a body bringing together national supervisory authorities, then newly established European Banking Authority ('EBA') could have a significant role to play in the aspects of this work involving national supervisors (in particular the supervision, preparation and early intervention aspects of this consultation). For the resolution and financing aspects, which involve other bodies at the national level, such as central banks and ministries of finance, further detailed consideration needs to be given towards the role of the EBA. Furthermore, the Commission plans to examine the need for further harmonisation of bank insolvency regimes with a report by the end of 2012 and, alongside the review of the EBA in 2014, will assess how a more integrated framework for the resolution of cross border groups might best be achieved. The Commission is not at this time proposing a European resolution authority.

18. How does all this relate to discussions at international level?

The Commission is helping to shape the work of the FSB and the G20, and is also closely monitoring other international developments. The G20 summit held in Toronto in June 2010 committed to the design and implementation of systems whereby authorities have the powers and tools to restructure or resolve all types of financial institutions in crisis, without taxpayers ultimately bearing the burden. The FSB last year adopted recommendations for reducing the moral hazard posed by systemically important financial institutions (SIFIs). A substantial part of those recommendations aim to ensure that SIFI resolution is a viable option. The ideas set out in the Consultation would, if adopted, constitute a significant step for the EU in delivering resolution framework called for by the FSB.

19. What are the main differences between what the EU is proposing and the US approach?

In the US, the Dodd-Frank Act has established a resolution framework for systemic institutions at group level. Both the EU and the US are accordingly working to develop mechanisms which should be capable of resolving or winding down failing financial institutions. The US approach intends to address systemic banks by taking failing institutions into receivership by the Federal Deposit Insurance Corporation (FDIC), under which their business will be transferred or wound down and the failed institution will be liquidated.

The EU framework discussed in this Consultation would also allow authorities to put banks into an orderly resolution in which their essential services could be preserved while the failed institution itself was ultimately wound down. However, in the cases where an institution is too large, complex or interconnected to be wound down in an orderly manner, the Commission is also considering equipping authorities with ambitious additional tools which would under stringent conditions allow a troubled bank to continue as a going concern, through write down of its debt, in order to preserve its economically important functions and 'buy time' for authorities to sell or wind down its business in an orderly manner. In order to prevent moral hazard, there would need to be strict conditions accompanying any such approach. These would include dilution of shareholders, changes to management, haircutting of creditors and re-structuring so as to ensure that the surviving entity was viable. Such operations would also need to adhere to strict EU state aid rules.